How to navigate the UK regulatory landscape in financial services M&A

There was a marked increase in merger and acquisition (M&A) activity in the UK’s financial services sector in 2024, with the number of deals up 26% year-on-year, according to EY analysis at the start of the year.

As the first half of 2025 progresses, the outlook remains robust with some optimism although challenges remain, including geopolitical and global trade tensions, the potential for increased inflation, uncertainty around interest rates and reduced economic growth.

The success of an M&A transaction in the financial services sector can be heavily impacted by the evolving regulatory and compliance environment. These changes can affect valuations (both upwards and downwards), increase risk and costs, and cause uncertainty and potential delays to a transaction. All of which could call into question the attractiveness and feasibility of a deal.

Engaging experienced legal advisers with specialist expertise in the financial services sector is crucial. They can help navigate the regulatory and other complexities, thereby smoothing the process and enhancing the likelihood of a successful transaction and a seamless post-completion integration.

Regulation, deal appetite and valuations

Last year's Court of Appeal decision Johnson v FirstRand Bank Ltd (London Branch) (t/a MotoNovo Finance) on undisclosed or partially disclosed commissions could have a wide-reaching impact on the value of certain books of business, such as vehicle loans or hire purchase agreements, where distribution channels relied on third parties to broker or introduce business.

The Supreme Court expedited the case appeals at the start of April. The industry will be eagerly awaiting the outcome, with the Supreme Court's decision expected in early summer.

Were the judgment to be upheld by the Supreme Court it would potentially mean that some businesses are facing significant remediation costs, and therefore a material reduction in the overall value of the business. For those businesses which struggle to deal with the impact of this decision, this might lead to distressed opportunities for willing buyers.

Changes in regulation and the way in which the Financial Conduct Authority (FCA) approaches its supervision of regulated business can impact valuations of certain types of financial services businesses. In the payments and e-money world, the recent low rates of FCA authorisation approvals has led buyers to target firms with existing licences, pushing up the value of regulated firms.

In the crypto space, impending regulation has led a number of participants to seek to exit the UK market, meaning there may be greater value in purchasing these businesses, provided activities can continue to be conducted compliantly.

Sealing the deal and seamless integration

Any change in control of a regulated business must be approved in advance by the FCA (and the Prudential Regulation Authority, if applicable), which means that all deals involving the acquisition of a regulated business will require a split exchange and completion to allow for the regulator to make its assessment.

In its October 2024 “Dear CEO letter”, the FCA confirmed it would assess individuals and firms acquiring or increasing control in regulated firms and challenge their suitability and the financial soundness of the acquisition. The FCA has also said it will use its enforcement powers, if a transaction completes without prior regulatory approval, by objecting to the transaction or initiating criminal proceedings.

The change in control process can be complex, involving structuring advice, applications to regulators and contractual drafting to ensure that consents are obtained and regulatory requirements are fulfilled. It is therefore essential to plan ahead and engage advisers with experience of making change in control applications to ensure the process runs smoothly

As well as the usual transaction-related considerations, transactions involving the disposal of a business by a regulated firm involve additional issues. Client migration must be effected in compliance with regulatory rules, so a well-managed customer-communication and client-consent programme is essential and should be factored into the deal timetable – as well as engagement with the relevant regulatory authorities.

For firms regulated by the Financial Services and Markets Act 2000, buyers need to obtain approval for any new senior management to be brought in, as well as to map in advance the responsibilities of incoming individuals, to ensure that, if there is a changing of the guard, there are no gaps in responsibility at a senior level. For payments and e-money firms not subject to the senior managers and certification regime, the FCA still expects to be told in advance of any changes to senior management. It could in theory remove a firm’s permission if it were uncomfortable with an incoming senior management team.

Especially in distressed transactions, where the target is at risk of administration or insolvency, regulated firms will have to satisfy regulators that there is an adequate wind-down plan in place so that, in the worst case scenario, the firm can cease its regulated activities with minimal adverse impact on clients, counterparties and the wider market. Again, prompt specialist advice is recommended to ensure that unnecessary delay does not cause a deal to fail, particularly when time will be of the essence in a distressed situation.

Regulatory capital's intricacies

The rules of the FCA require regulated firms in the UK to maintain a certain level of capital to withstand the risks they may be exposed to in their businesses. These regulatory capital requirements are often a key consideration for deals in the financial services sector and they can impact at various points of a transaction.

A buyer’s regulatory due diligence should include assessing whether there are any defects in the target’s regulatory capital instruments and its approach to internal capital and risk assessment. Any defects should be addressed and resolved as part of the transaction, which could involve informing the FCA of the defect, restructuring the target’s group or issuing further regulatory capital instruments

When financing a transaction, buyers should bear in mind that borrowing and granting security by a regulated target and its group can adversely affect the group’s regulatory capital position and potentially result in it no longer having sufficient capital to meet its minimum requirements. There are ways to structure around this issue (including the recent trend for establishing a new "topco" incorporated in the Channel Islands) but they require careful specialist planning and can take time.

Osborne Clarke comment

Regulatory capital is often the subject of discussion when negotiating the completion accounts mechanism. Cash held to meet regulatory capital requirements may be treated by a buyer as “trapped cash” and excluded from the calculation of the equity value of a business. This may have a material impact on a seller’s proceeds from a transaction and so is increasingly becoming a matter for debate. If the buyer is already regulated, thought must be given as to the capital impact of an acquisition and what cash within the target could be released when calculating capital on a consolidated basis.